June.15.16Personal Finance
what is value investing
Money Matters with Nimi

What is value investing?

Value investing is an investment approach that is based on the premise that with some effort, you can find good, strong companies whose share prices have fallen, so offer good value for money. It was made popular by Benjamin Graham, and Warren Buffet, who largely based his investment decisions on the tenets of value investing and used this approach to build his extraordinary fortune. According to Warren Buffet, “value investing is the real form of investment, anything else is pure speculation”.

Assumptions of value investing

More often than not, the stock price does not reflect the real value of the stock itself. Market volatility, emotions and fear drive price volatility. The result is that stock prices will be either the stock prices will be overvalued or undervalued at a particular time.

Nobody knows exactly when the market will reflect the stock’s true or fundamental value; it could take months, years, even decades. However, its future prospect and potential growth is the best indication of a stocks true value. Fundamental analysis helps one in uncovering hidden gems in the stock market. Such companies would usually have valuable assets, a strong balance sheet reflecting stable earnings and dividend history with potential for growth, an experienced board and management team, and would command a sizeable market share. How a company’s financials stand, its credit ratings, and industry outlook; all these come into play and are key to fundamental analysis.

Value investing is somewhat subjective and two investors may have exactly the same information on a company and yet place differing values on it using different valuation methods. Companies of different sizes or in different sectors may differ in terms of what is considered to be of good value. For example, what is cheap for a banking stock may not be cheap for a company that produces consumer goods.

Value investing thrives on fear and uncertainty

Markets often over react to negative news with the result that good stocks fall far below their fundamental values along with less attractive stocks. Value investing relies on the psychology of fear in the market. When there is fear in the market, many “investors” start to sell in a panic. In this process, some attractive stocks fall below their fundamental values ready to be snapped up by the discerning value investor.

Bargain hunters

Value investors are often labeled “bargain hunters” as they actively seek out the stock of companies that they believe are undervalued; they are not just looking to buy cheap stocks but are “smart” shoppers looking for the stocks of companies with good fundamentals. When they are undervalued, they buy them, and where they are overvalued, they stay away from them.

The Cash Advantage

As far as possible, it is advisable for investors to hold some cash in their portfolios at all times. Stockmarket investing comes with a degree of risk. It is thus important to hedge your risks by diversifying your investment portfolio to include not just stocks but other asset classes such as bonds, real estate and cash; this helps reduce volatility in your portfolio and protects your net worth. Value investors with cash holdings in their portfolio have the luxury of buying great stocks at relatively low prices during a market correction or crash; this can lead to a solid appreciation in their portfolios over a longer period of time.

Think Long Term

Markets tend to overreact to good and bad news and price movements may not necessarily correspond with a company’s long-term prospects. Value investors believe that although the stock market may be volatile in the short-term, and may not capture the fundamentals of a business, in the long-run, the fundamentals are of paramount importance. This is not about making quick money; thinking long term forces you to think more about quality. As Warren Buffet comments, “Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be mis-appraised.”

Uncertainty favours long term value investors as it creates fear, leading to panic selling, which forces prices downward regardless of a company’s long term prospects. They are better able to weather the storm of market volatility as they expect that its long term economic value should eventually pull a company’s stock price back up; it doesn’t matter that its share price goes down temporarily.

Are you still apprehensive about the stock market?

Many people continue to be apprehensive about the stock market, yet we are experiencing a time that can be described as the value investors’ dream as we continue to see real discounts among companies with strong underlying fundamentals offering significant buying opportunities. Many companies have hit unprecedented lows in their share prices and some of them represent good value that make them attractive buys for the serious long term investor, in spite of the fact that their share prices could still drop further.

It is important to adopt an investment strategy that will guide your overall investment decisions about which stocks to purchase and when to buy or sell. The style that you ultimately choose should largely depend on your objectives, your expectations of long-term returns and your risk appetite.

Equipped with the right tools, knowledge, research and of course, professional support, you can equip yourself to make better informed decisions. For most investors however, it is far simpler to take advantage of the opportunities that exist by accessing the market through mutual funds and discretionary portfolios where all decisions are made on your behalf by experienced professionals.

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One Response to “What is value investing?”

  1. ce says:

    Hmm! Very insightful.

    Please how can an individual without good knowledge of the NSE and general stock tools leverage on this, seeing that the Nigerian economy at the moment, in my opinion, is at a good time for value investing?

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